The Advantages of Dividend Stocks

To make a well-informed decision of whether dividend stocks are right for you, evaluate their pros and cons. The following are the advantages of dividend-paying stocks — stocks that not only change in value but also pay a portion of the company’s profits to the shareholder — assuming, of course, the company is profitable.

This is your money; so don’t let anyone tell you how to invest it. As the investor, you need to determine whether the pros outweigh the cons or vice versa. Dividend stocks can become a more- or less-attractive option as conditions change.

Gain two ways to win

With dividend stocks, you have two ways to win: when the share value rises and when the company cuts you a dividend check, paying you a portion of its profits. If the share price rises by 4 percent, and the company pays a 3-percent dividend, you pocket a 7-percent profit, minus taxes, of course. (Or you can reinvest your dividends to buy more shares.)

In addition to providing two ways to win, the share-price-plus-dividend advantage allows you to hedge your bet. If share prices fall by 4 percent and the company pays a 3-percent dividend, you lose only 1 percent of your investment. Of course, companies can always choose to slash dividends, so you’re not completely safe, but you’re often safer than if you’re relying solely on rising share prices to score a profit.

Secure a steady stream of income

With most other investments, you don’t realize a profit until you sell. Before you tell a broker to sell, any profit is a paper profit — you can see it on a statement, but you can’t spend it or stick it in your piggy bank.

Dividend stocks are different. Companies pay out the dividends in cold, hard cash. These aren’t paper profits that can disappear in a bear market. Dividends are money in your pocket, and after they’re paid they can’t be taken from you.

Achieve profits and ownership

If your stocks don’t pay dividends, the only way you can wring cash out of your investment is by selling your shares. Unfortunately, selling shares means relinquishing your ownership in the company — something you may not want to do if you think the company will grow and the share prices will rise. With dividends, you receive a return on your investment while holding onto the shares for potential capital appreciation.

Compound returns via reinvesting

Compounding is one of the most powerful forces in the world of investing. It’s like the old riddle: How much wheat do you end up with if you place one grain of wheat on a checkerboard square and then double the amount each time you move to the next of the 64 squares? Answer: Enough grain to bury India 50 feet deep! That’s a little exaggerated in terms of investing, but compounding returns follows the same principle.

Hedge against inflation: Another way to WIN

In August 1974, then-president Gerald R. Ford encouraged his fellow Americans to Whip Inflation Now (WIN). Inflation was at about 11 percent back then, and just about everybody in the country was wearing a WIN button. One of the best ways to keep inflation from taking a bite out of your investment earnings is to invest in dividend-paying stocks. The big advantage dividends hold over other income generating investments is they have the potential to keep pace with inflation. As prices rise, profits also tend to rise, and companies can afford to raise their dividend payments.

Inflation takes a bite out of earnings. With inflation at a modest 3 percent, a 7-percent annual return on an investment (not bad) nets only a measly 4-percent annual gain.

Bank on the buy-and-hold advantage

Dividend investors tend to be more committed than non-dividend investors. They’re in the market for the long haul and want to own shares in companies that deliver returns in good times and bad. As a result, dividend shares tend to out-perform non-dividend shares when the market heads south.

Stocks that offer only capital appreciation through rising stock prices have little chance of providing a positive return when stock prices are falling. Thus, many investors sell these stocks sooner than dividend stocks.

Baby boomers face an increasing need to score supplemental income, and the smart ones who have money to invest are likely to consider dividend stocks as a prime source of that supplemental income. Traditionally, retirees tend to reposition their assets into more conservative portfolios that focus on income generation over capital appreciation through growth. Nobody has any reason to believe that this trend will change when the boomers retire. Assuming this scenario happens, both stock prices and dividends should rise accordingly.